Getting Wisconsin the Electricity it Needs

Progress to Date: September, 2000

• The Wisconsin Generation Problem
• Proposals for PSC action

1. Encouraging New Rate-Based Generation
2. A Margin on Purchases
3. Affiliated Merchant Plants
4. Conclusion

Substantial progress has been made in Wisconsin during the last three years in restructuring of our electric industry. The state has adopted a careful, sequential approach to change, rather than the big bang approach to deregulation pursued by some other states. As a result, Wisconsin customers have not been subject to the dramatic price increases that are being experienced in California and other states.

Rates have remained relatively low and stable. At the same time, Wisconsin has become the first state in the country to restructure the transmission portion of its utility business by creation of a separate transmission company focused solely on the provision of transmission service, including construction of new facilities essential for reliability and necessary for any transition in the future to a competitive market. Wholesale merchant plants have been authorized in order to encourage

new investment in power plants within the state. More than 3000 MW of new merchant plant capacity has been proposed in the last four years, with approximately 1175 MW constructed or under construction.

The PSC has approved one transmission project in western Wisconsin (Apple River-Chisago) and another application is pending. The development of renewable energy resources has been promoted and a comprehensive public benefits program approved to address low-income issues and to increase efficiency and conservation.

One of the most difficult issues that faces Wisconsin in moving forward with restructuring in light of the dramatic price increases experienced in California, New York and elsewhere this summer is: How to create a market structure that will actually produce real, long-term benefits for customers? To address this thorny issue, the Wisconsin Legislature in 1999 Wisconsin Act 9 directed the PSC to perform a detailed market power study. This study is expected to be finished at the beginning of 2001. The study should begin to identify the market power problems that exist in Wisconsin as a result of concentration in ownership and control of generation, and also identify possible solutions to these concerns. This summer's experiences in California and elsewhere have proven conclusively that deregulation without solving the market power problem is a disaster.

The Wisconsin Generation Problem

In the meantime, while Wisconsin continues to work on electric restructuring in a careful and deliberate fashion, it is clear that the state faces a continuing electric generation shortage. As load grows, it is essential that new power plants be built to serve all customers economically and efficiently.

No new utility rate base plants are being proposed by the investor-owned utilities at this time. While several independent power projects have been announced in the state, it is unclear for a variety of reasons whether these plants will be built. This uncertainty is unfortunate and leaves the state at substantial risk.

In addition, the state faces significant future price energy risk because all of the new generation proposed to date (with the exception of a small amount of new renewable generation) would burn natural gas. There is a serious question about the adequacy of our pipeline infrastructure to support these projects and, given the dramatic increase in the cost of natural gas experienced this summer, increasing concern about the wisdom of reliance on gas for all new generation.

Several impediments to new construction are evident:

• Most of the state's investor-owned utilities are unwilling to build new generation today on a traditional regulated (rate base) basis to meet their obligation to serve, believing such construction is too risky in light of potential changes in regulatory policy.

• Some utilities also may be holding out for authority to build on an unregulated basis because they believe that course will be more profitable for shareholders.
• Wisconsin’s investor-owned utilities have no incentive to purchase from proposed independent power projects because under current regulation, a public utility earns no profit or margin at all from purchases. It can only earn a return or profit through the ownership of generation.

The result of this combination of circumstances is that utility stock prices have declined due to diminished earnings potential and the state faces a generation shortage.

Because our largest public utilities do not want to build traditional, regulated generation, and because they have no incentive to purchase from third parties, they have begun to look for ways to deregulate their existing generation to improve earnings and to build new unregulated generation themselves. This approach raises a number of concerns that cannot be evaluated and addressed until completion of the PSC's market power study and development of a market structure that is likely to produce real, long-term benefits for customers. Essentially, proposals to deregulate Wisconsin’s generation plants let the horse out of the barn before the corral has been designed and the fences have been built. This would be a huge mistake.

Given these facts and concerns, this Action Plan suggests a number of interim steps that should be taken by the PSC to break the logjam without prematurely deregulating Wisconsin’s existing generating plants and to make sure that the right mix of new generation is constructed in Wisconsin over the next several years.

This Action Plan also proposes a mechanism to ensure that, as a state, we examine the pros and cons of building some new generation that uses clean coal technologies, rather than depending entirely on natural gas. The Plan does not advocate such construction. However, it is clear that without positive action, such plants are unlikely to be proposed today because of the significant risks posed by long construction lead times and high fixed costs in a period of regulatory uncertainty. A failure to consider alternatives is not in the state's interest.

In this regard, we support a thorough examination of the pros and cons of the development of a major coal plant utilizing clean coal technology in eastern Wisconsin, with equity participation rights for all of Wisconsin's smaller utilities (including cooperative and municipal utilities), or at their option output purchase rights. The plant should be constructed on a cost of service basis with appropriate equity compensation for the primary utility proponents that are able to provide an attractive site and other infrastructure and expertise necessary for project development.

We also recognize that significant concerns exist related to the current ability of Wisconsin utilities to finance this sort of project. Those who are interested should examine (i) innovative ways to finance a new plant, without deregulating existing generation, and (ii) seek out new equity partners.

Proposals for PSC action

While public utilities may be reluctant to build new rate base generation, they have an obligation to meet the requirements of their customers reliably and must be willing to build plants to meet those needs, when necessary. This is their job. However, it also is true that today’s uncertainty with respect to rate recovery is real and needs to be addressed by the PSC, or rate base plants are not likely to be built without controversial and contested regulatory orders to build. The recently enacted Reliability 2000 legislation gives the PSC the explicit authority to order utilities to build needed new generation.

We recommend that the state's public utilities be permitted and encouraged to build rate base generation, where they demonstrate that this course is as good or better for customers as purchases available from third parties, with rate recovery mechanisms for any new rate base plant defined and agreed to at the outset by the PSC in a legally binding order, which has the force of a contract between the state and the public utility.

We suggest the following model to provide the necessary incentives to build:

1. New rate base plants should be treated as stand-alone assets for rate-making purposes as if provided under contract by the utility, acting as a merchant, to the utility's distribution arm. The rate of return for the plant, the capital structure and expense recovery mechanisms should be proposed by the utility and established at the outset in a PSC-approved "purchased power agreement" between the utility and its distribution arm. The "agreement" should:

• establish performance guarantees


• fix certain cost elements


• give the utility an incentive to enhance earnings if it can beat performance requirements or achieve operational savings beyond the benchmarks agreed to in the "agreement," provided reliability is maintained

As an incentive to get needed new plants built promptly, the PSC should consider approving a capital structure and return for new rate base plants that are comparable to the capital structure and return of independent power producers, taking account of risk differentials.

B. The "agreement" must address potential stranded costs in the event retail choice is implemented in the future. The PSC should determine up front that if the utility wishes to take the associated risk, the plant will not be considered in any future stranded benefit/stranded cost calculations related to utility's other rate base assets in deregulation. As an alternative, a utility should be permitted to propose a specific risk allocation formula up front such as, if the value of the plant is above market at the time of deregulation, public utility shareholders will receive 50% of that premium value, with ratepayers receiving the other 50%. Conversely, if the plant has a value that is below market, the same percentage sharing would apply for the plant on a stand-alone basis. Utilities should be permitted to suggest different risk-sharing formulas based on other provisions in the "agreement," including full stranded cost protection for high capital cost, long lead time plants. The important thing is that upon approval of construction of the plant, the utility should have certainty as to its risk exposure related to the plant if retail choice is approved in the future. Ratepayers of public utilities would receive the same certainty and recovery for costs of the plant would be established in an "agreement" approved and regulated by the PSC. Municipal utilities and cooperatives that are equity participants in a plant, and their members, would also be able to address their stranded cost risk exposure. None of the "agreement" provisions, however, should tie the PSC's hands in structuring a future market or remedying market power problems that may exist in the future.

C. If a rate base plant that employs state-of-the-art clean coal technology is approved for construction, the PSC should examine whether existing rate recovery mechanisms are adequate given the greater risks and longer construction times associated with such plants, or whether reasonable alternative cost recovery mechanisms are appropriate. Approval of construction of such a plant also would require offsets, such as closure of older coal plants, so that the net environmental impact is positive.

D. In order to reduce the amount of new generation required to be built, utilities should be permitted to pass through costs of beneficial load control and load management programs, including market-based curtailable and similar programs, and to earn a return on cost-effective energy-efficiency investments.

E. In order to promote the development of small scale (50MW and less) distributed generation, the PSC should provide an incentive if the generation is sited to provide needed transmission support, consistent with Midwest ISO and Wisconsin ATC plans.

The PSC should immediately adopt a policy that permits public utilities that make firm purchases to meet their capacity and energy obligations to their native load customers to earn a reasonable margin or profit on these purchases. The regulated electric utility industry is probably the only industry in the country where a firm acting as a middleman, purchasing at wholesale and aggregating customer needs at retail, does not add a margin for itself to the wholesale cost of the product. This discrepancy has not been an issue in the past because utilities have built plants to meet virtually all of their requirements. However, in the changing environment, long-term firm purchases have become a much more important part of the power supply equation. Customers want their utilities to purchase power from third parties when the cost will be lower than building and want them to do a good procurement job on behalf of customers. Public utilities should be compensated for this important job and regulation should not provide a disincentive to purchase rather than build. PSC-approved rates should provide an incentive to do a good job of securing needed capacity and energy by purchase on behalf of native load customers. The current regulation policy of providing zero margin is contrary to customers' interests and to the Legislature's objectives of promoting development of wholesale merchant plants and encouraging new participants to enter our generation market.

For these reasons, we propose that, effective immediately, the PSC permit a reasonable margin to be earned by public utilities in rates on prudent purchases on behalf of native load customers.

3. Affiliated Merchant Plants

A similar contract approach should be taken for affiliated merchant plants owned in full or part, provided that the public utility passes the required market power screen or adopts a mitigation plan approved by the PSC that addresses market power issues. In order to facilitate the development of affiliated merchant plants, if the PSC determines that a purchase from a specific affiliated merchant plant is beneficial for ratepayers and prudent in comparison with alternatives, the three-year limitation on sales back to the distribution arm of the affiliate could be lifted for that plant. This will require a legislative change.

4. Conclusion

Customers First! advances these proposals to ensure that the voice of all customers in the state is heard in the debate over further changes to our electric utility system. A strong Wisconsin economy is driving power demand upward, straining transmission and generation systems. Wisconsin is facing a power shortage, and we need to find responsible ways to get the electricity our state needs.

At the same time major price increases in deregulated markets like California demonstrate clearly that radical deregulation of power plants is not the answer. "GenCo" proposals that take our state’s power plants away from ratepayers would be an economic and reliability disaster for the state’s economy. We have avoided these damaging effects by a careful, sequential approach to change in the industry. We should stay our course, and reject risky schemes to change the way we do business in this critical sector.

The one sure and constant need is for a source of reliable and affordable energy for the people of Wisconsin. That is our "bottom line." We are open to debate and discussion of proposals to help meet that goal, but we must never lose sight of the need to keep our focus. We believe the proposals we have put forward will help meet that goal, while protecting the advantages Wisconsin already holds in this rapidly changing environment.